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Life As Libor Traders Knew It

Traders say discussions on setting the rate were routine after the money markets froze in 2007.

Regulators probing the alleged manipulation of global interest rates are focusing on what traders involved in setting the benchmark say were routine discussions condoned by their superiors.

Staff responsible for submissions to the London interbank offered rate regularly discussed where to set the measure with traders sitting near them, interdealer brokers and counterparts at rival banks, according to money-market traders with direct knowledge of procedures at three firms. The talks became common practice after money markets froze in 2007, making it difficult for individual bankers to gauge the cost of borrowing from other lenders, said the traders, who asked not to be identified because they weren’t authorized to speak about the subject.

“A few hundred people, mostly based in one city and sitting in close proximity to each other, set an index rate for trillions of dollars of securities with little or no oversight,” said Mark Sunshine, chief executive officer and chairman of Veritas Financial Partners, a Florida-based firm that provides loans to businesses and real estate companies. “That cannot continue. The mechanism itself, the oversight and the penalties if violated, are woefully inadequate.”

The investigation by regulators in the U.K., U.S. Canada, Japan and the European Union, is the latest black eye for an industry smarting from criticism that it caused a global financial crisis in 2008. The probes have called into question whether firms can be trusted to set with no regulatory oversight a rate that is the basis for about $360 trillion of securities from floating-rate mortgages to commercial loans.

“Given the number and the value of transactions in interest-rate derivatives, and the crucial role these products play in the management of risk, any confirmed manipulation of these interest rates would probably imply a very significant cost to the European economy,” EU Competition Commissioner Joaquin Almunia said in a speech last week.

Traders interviewed said there were no rules stopping talks between employees, or guidelines on how the rate should be set. The British Bankers’ Association, the London-based lobby group that publishes the rate, said it has never required banks to erect Chinese walls between those setting the rate and traders making bets on the future direction of the measure, leaving it up to the firms themselves and their regulators.

Employees interviewed by Bloomberg said the interbank lending market had been broken since before Lehman Brothers Holdings Inc. filed for bankruptcy in September 2008.

Reluctance to Lend

The difference between three-month dollar Libor and the overnight indexed swap rate, an indicator of banks’ reluctance to lend to each other, peaked at a record 364 basis points on Oct. 10, 2008. The spread averaged about 10 basis points in the five years up to the collapse of Lehman Brothers Holdings Inc. and has averaged 45 basis points since.

Traders say the lack of interbank activity made it impossible to calculate accurately where borrowing costs should be fixed. Instead, rate-setters resorted to talking with other market participants, checking previous submissions from competitors and scanning the news to come up with a best guess of what they might have to pay for short-term cash if a market existed, according to the traders.

During the crisis, banks routinely misstated borrowing costs in the BBA process to avoid the perception they faced difficulty raising funds, Tim Bond, then head of asset allocation at Barclays Capital, said in a Bloomberg Television interview in May 2008. In a report the same year, the Bank for International Settlements, the central bank for central bankers, questioned the accuracy of Libor quotes, saying they could be influenced by “strategic behavior.” The BIS said firms would be “wary of revealing” information that could signal stress.

“Libor is not a market interest rate,” said Christoph Rieger, head of fixed-income strategy at Commerzbank AG in Frankfurt. “The spot fixings are at best bank guesses of a hypothetical interbank” borrowing rate. “For that reason, this will always be subject to controversy.”

The benchmark is generated through a daily survey of firms conducted on behalf of the BBA in which lenders are asked how much it would cost them to borrow from one another for 15 different time periods, from overnight to one year, in currencies including dollars, euro, yen and Swiss francs. After a predetermined number of quotes are excluded, those left are averaged and published for each currency by the BBA before noon.

While the BBA says typically only a bank’s Treasurer or other nominated individual can make a submission, a trader at one firm said a large number of employees had access to the software used to make a bank’s submission and could overwrite others’ figures. On any given week, several different traders might input the rate and on at least one occasion a graduate trainee was deputized to do so, according to the trader who had direct knowledge of that firm’s practices.

Trader Dismissed

Tan Chi Min, a trader dismissed by RBS, said in a lawsuit filed in Singapore in December that he and at least seven of his colleagues at the Edinburgh-based lender were regularly consulted on the bank’s yen Libor submissions by rate-setters and senior managers.

There was no “regulation, policy, guideline or law” in place, Tan said in the filing. A person familiar with RBS’s rate setting procedures corroborated Tan’s account.

RBS responded in January, saying in court filings that it fired Tan because he tried to improperly influence the bank’s rate setters from 2007 to 2011 to persuade them to offer Libor submissions that would benefit his trading positions. Tan wasn’t reachable for comment.

Traders at two more firms said they also discussed where Libor would be set with managers and rate-setters because that is how the industry operated.

“As all contributor banks are regulated, they are responsible to their regulators, rather than us, for maintaining appropriate Chinese walls,” the BBA said in a statement.

The U.K.’s Financial Services Authority imposes no specific restrictions on banks to prevent communications between traders and rate-setters over Libor beyond a broad requirement for them to identify and prevent conflicts of interest, according to guidelines posted on its website. A spokesman for the London-based watchdog declined to comment beyond the guidelines.

Investigators are now scrutinizing e-mails and instant messages between traders and rate-setters for evidence that traders not only discussed Libor, but collaborated to rig the rate to profit from wagers on future interest rates.

Canada’s Competition Bureau said in court filings that one bank had confessed to participating in a conspiracy among employees at HSBC Holdings Plc (HSBA), Deutsche Bank AG, ICAP Plc (IAP), JPMorgan, RBS and Citigroup Inc. to rig the price of derivatives globally by manipulating Libor.

UBS was the bank that alerted Canadian regulators to the alleged conspiracy in return for immunity from regulatory penalties for the firm, three people with knowledge of the inquiry said last month.

A UBS employee, identified only as Trader A in the Canadian court documents, began in 2007 to contact employees at other banks to discuss his market positions and a desire for a “certain movement” in yen Libor, according to the filings. Some of those contacted said they would try and facilitate his requests by influencing their own banks submissions, according to the documents, filed at the Ontario Superior Court in May.

Traders involved say the existence of such correspondence shows they weren’t trying to hide their acts from superiors. They didn’t know they were in breach of any rules, they said.

Individuals and firms found to have engaged in wrongdoing would likely face demands from regulators to return any illicit profits, said Jordan Thomas, a former enforcement attorney at the U.S. Securities and Exchange Commission who now advises whistle-blowers at Labaton Sucharow LLP in New York. They may also be fined and would be forced to improve their business practices to prevent a similar situation arising again, he said.

“These cases have put the spotlight on the failings of Libor and will hopefully spur demand on regulators to assess this,” said Richard Werner, a professor at University of Southampton, England. “The danger is that the focus is too much on individual cases. This is a systemic problem.”

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